The Effect of Competition on Dishonesty, Trade, and Consumer Trust

This paper considers a multi-period two-sided asymmetric information model with infinitely long-lived sellers and short-lived buyers. I assume that two exogenously given qualities are offered in the market. Each period, a consumer, who is uncertain about the quality of the offered product, observes her pairwise matched seller’s price and a noisy signal of quality that cannot be manipulated by the seller. Prices are fixed and it is common knowledge that consumers are not willing to pay a high price for the low-quality product. A matched seller with a low-quality good can choose to be either honest (by charging the lower market price) or dishonest (by charging the higher price). Sellers’ incentives to misrepresent quality depend on how current trade outcomes affect future access to consumer traffic. I show that the strength of the informational role of prices is non-decreasing in the intensity of competition for future consumer traffic in equilibrium and that consumers do not benefit from more intense competition.